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Analysis of ethical issues in M&A is important but not easy. Ethical issues pervade the M&A environment. And as I argued in Chapter 1, ethics is one of the pillars on which stands success in M&A. Therefore, the M&A deal designer must learn to identify, analyze, and act on ethical issues that may arise.

This chapter has sketched a framework of reflection that draws on the long literature of ethics. Consequences, duties, and virtues stand out as three important reference points for reflection. Nevertheless, the results of such analysis are rarely clear-cut. Indeed, the five cases outlined in the introduction to this chapter will find rational arguments on each side of the question and raise classic problems for further consideration:

1 Prettying up a firm for sale. In general, this book takes a strong stance against earnings management. Chapters 16 and 17 spell out why. As usually practiced, earnings management fails all three ethical tests: It breaks duties to shareholders and society; it hurts shareholders and employees; and it seems to corrupt those who practice it. In the mid-1980s, the CEO of CUC Inc. sought to prepare the firm for sale. Part of this entailed the use of aggressive accounting policies to improve the financial track record of the firm. Ultimately, the firm fraudulently booked nonexistent sales. After acquiring CUC in late 1997, Cendant Corporation discovered an estimated $500 million in fraudulent revenue booked at CUC over the previous three years. The CEO was indicted (and pleaded not guilty). The practice of prettying up a target company for sale in less dramatic ways is thought to be widespread. Is this unethical? One issue here is intent: Is it to clarify or deceive? Another issue is consequences: Who will be helped or hurt? A study by William Shafer (2002) found that materiality of the fraud would influence the likelihood of committing fraud by financial executives: The less material, the greater the likelihood.

2 Persuasion of growth prospects. Like the problem of prettying up, the ethical judgment on conveying growth prospects hinges significantly on questions of intent and consequences for the other party. Through the 1990s, Tyco International pursued an aggressive strategy of growth by acquisition that relied on creating the appearance of high growth, when in fact the companies acquired were mature and growing slowly. The appearance fueled expectations of prolonged growth, granting Tyco a high share price, and therefore a strong acquisition currency with which to do more deals. The limits to high rates of growth are obvious. (This kind of “momentum acquiring” is discussed in detail in Chapter 17.) Suddenly, in January 2002, Tyco announced that it would not only stop acquiring, but also split up the firm. This burst the bubble of growth expectations, leading ultimately to a collapse in the share price, investigations, indictment of the CEO and CFO, and write-offs for accounting errors. Tyco is a strong cautionary tale against momentum growth. Many companies aim to persuade investors of good growth prospects even when that growth is uncertain. Be cautious about how the effort to persuade investors affects others, how it ignores or respects duties, and how it corrupts or strengthens the persuader.

3 Selling at a low price and directors’ conflicts of interest. In 1980, the directors of Trans Union Corporation approved without much analysis or discussion a leveraged buyout proposal from the CEO at a relatively low price. A number of the directors were friends or affiliates of the CEO. Details of this case are given in Chapter 26 and in the excerpts of the court’s opinion, found on the CD-ROM. The core issue here is the directors’ faithfulness to their duty to shareholders. It may be that competing higher bids are unrealistic, not credible, or unlikely to gain financial backing, in which case a sure thing at a lower price may actually be in the shareholders’ best interests. But directors have a strong obligation to make such a decision at arm’s length, free of conflicts or even the appearance of conflict arising from affiliation with the CEO. On its face, the sweetheart deal for the CEO would have adverse consequences for the public shareholders. And one could be concerned about the corrupting effect of the conflict of interest on the CEO and directors. The court judged the directors to be personally liable for the shareholders’ opportunity cost in the Trans Union case.

4 Bargaining power. As an end in itself, the exercise of power would be condemned by many ethicists. But power is rarely exercised in a vacuum. Many companies cultivate and exercise power consistently with duty toward shareholders, customers, or other stakeholders, and conscious of the consequences imposed on other parties. In 1988, Salomon Brothers, the leading bond-trading house in the world, refused to provide acquisition financing for the takeover of RJR Nabisco unless it was to be listed as the lead underwriter, ahead of its rival, Drexel Burnham Lambert. This killed a proposal that would have united warring parties in the deal. More details on this case are given in Chapter 31. In this instance, the warring parties were all powerful players, and the banker-client relationship was unclear and shifting rapidly; the effect on duties is ambiguous. And the effect on RJR Nabisco’s public shareholders was positive: They received a much higher payment for their shares.

5 Greenmail. On the surface, paying greenmail seems to give in to coercive power, and possibly to serve the interests of management of the target firm, rather than its shareholders. But the discussion of Walt Disney’s case suggests that doing so preserved and increased value for Disney’s shareholders, employees, customers, and suppliers.

These and other ethical themes will appear throughout M&A. The thoughtful practitioner is counseled to reflect carefully and do what is right.